What is a Debt Settlement Letter?

A debt settlement letter is often written when a debtor is having difficulty paying a debt owed to a lender. It offers to settle the debt for less than the total amount owed. It usually is used when the debt amount is accruing interest but is unsecured by any property, such as in the case of outstanding credit card debts.

A debtor can write a debt settlement letter on his or her own, or it can be issued by a debt settlement company or a debt settlement attorney. Lenders of unsecured loans, such as credit card companies, lend money with the understanding that the loan will be paid back with interest to compensate the lender for being willing to loan the money. Higher interest rates are charged for these loans than for secured loans such as mortgages, because the risk to lender is higher.

Without property the lender can take if the debtor defaults, the lender risks not getting any of its money back. A lender might be willing to consider a debt settlement plan as set out in the debt settlement letter if the lender is afraid that it will be able to recover little or none of the principal and interest that it is owed. Many lenders would rather recoup some of the money they are owed rather than having to write off the entire debt. The offer to settle the debt for less than the total amount owed contained in the debt settlement letter will trigger one of the responses from the lender: a rejection, a counter-offer or an acceptance.

It is unlikely that a lender will even consider a debt settlement letter unless the debtor is behind in his or her payments. This is because the lender’s first priority is to recover its principal and the interest that has been agreed to. In this case, the lender will reject the debt settlement offer. It might also reject the offer if the lender knows that the debtor is due to receive a large sum of money, such as an inheritance or a court judgment.

If the lender makes a counter-offer, the debtor must consider whether it is a plan that the debtor is able to follow. A plan that puts the debtor back in a position of being unable to pay is generally not helpful. Often, a counter-offer is simply a beginning position from which the lender will negotiate.

Acceptance of the debt settlement letter’s offer means that the debtor will be obligated to stick to the new agreement. The debt will likely show as “settled in full” instead of “paid in full” on the debtor’s credit report, which can do damage to the debtor’s credit rating. It is, however, less damaging to a credit rating than defaulting entirely on the debt.